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What is a covered call?

What is a covered call?

A term that you have likely heard a lot in discussing trading is “covered call,” but you may be none the wiser as to what the term actually means. Or perhaps you have a general idea, but you are unsure as to how you specifically can take advantage of it. So what exactly is a covered call? In its most basic terms, a covered call strategy is a neutral options strategy, where an investor gains income by writing call options to generate income on a long position investment; selling covered calls can be a good way to get some extra income without playing the market too much, selling your stock, and—it reduces your risk typically by 1 to 3% or so depending on the stock and where you sell the call option. It’s a slightly more conservative way to make a gain, though the gains may be a bit smaller.

On the other hand, buying a call option, is a purely speculative play with a small amount of money (let’s say $500) that can lead to large gains (maybe doubling your $500) or you could lose 100% of the $500.

This is why we prefer the covered call strategy over buying calls. To learn more about covered calls, watch the video below, which details what a covered call is, how you can use it, and gives you some examples.

Video Transcription

Okay, today we’re answering the question what a covered call is? This is one of the first strategies that most investors are exposed to when they’re trading options. I like this strategy. It’s a great way to target a consistent income on stocks that you already own. It’s a short-term way to look at a potential down move on a stock and to at least make a little bit of profit off of that.

Let me give you an example, let’s say that you have XYZ stock trading at 100. You buy 100 shares of the stock, here’s a $10,000 investment.

Now let’s assume that this stock has a 20% return a year, you’d make a $2,000 return. Which is pretty good. Now, look at if you were to sell call options every month on this stock. That’s all you’re doing, you’re selling a call option, you get paid for that, you could do this each month on stock. Basically what you could do is sell one call option contract with 30 days to expire, roughly. Get paid, let’s just say a $1.50 a share. That’s $150 a month that you can target on certain stocks, times that by 12, that’s another $1800 worth of profit that people can target when they’re doing covered calls. So add the two together, you have the $2,000 return on the stock, you have the $1800 return on your call options, and now your profit is nearly doubled, and you’re seeing yourself with $3800 in profit at the end of the year.

OptionsANIMAL can also help you to learn more about covered calls, call options, short calls, and more, with the following resources: